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Political Prognostications: Singin' the Death Tax Repeal Blues

As I write this column in early December 2006 the Democrats are crowing about their substantial congressional victories while assuring the nation that they will work with their Republican colleagues in a spirit of bipartisanship – the typical inside-the-beltway blarney. Meanwhile, a plethora of pundits are prognosticating about potential legislation in this new political world.

Although I am neither pundit nor Washington insider, indeed I tend to ignore them all, I’ve been asked for my thoughts on the recent election’s impact on the estate tax.

We are now over five years into the 2001 tax reforms that initiated a gradual rate reduction and exemption increase. (If you kick the bucket in 2007, your estate tax rate will be 45 percent after “enjoying” a $2 million exemption.) As you undoubtedly know, that law’s climax is total estate-tax repeal in 2010 followed by a dreadful morning after, with rates returning to 55 percent and a measly $1 million exemption for people who are unlucky enough to hang on until 2011.

As people figured out the ridiculousness of the 2001 law, most everyone came to believe that 2010 would never arrive. Well, I mean no one believed that the outright repeal for one year or the reinstatement of the high rates/low exemption in 2011 would stand. Instead, there was a widely held belief that Congress would act in the interim (hopefully far in advance) to stabilize the estate tax, either by killing it entirely, or by instituting a permanent rate, exemption, etc. regime.

The estate-tax repeal movement quickly gained steam as President Bush began pressing for total repeal of the “death tax.” Small businesses and family farm groups succeeded in building a great deal of public distaste for the tax, even though, frankly, few would be likely to ever would have sufficient wealth to have to pay it.

When the Republicans took majority control of the Senate in 2002 (they already controlled the House of Representatives), some thought the death tax would die once and for all. Indeed, the House subsequently voted several times (e.g., during 2003, 2005 and 2006) for permanent repeal. Of course, the cynic in me knew that that was just grandstanding for the folks back home. Our representatives knew full well that the Senate would have trouble coming up with the sixty votes that their rules require to follow suit. Indeed, the Senate never did.

Then came Iraq: budget deficits mushroomed. Katrina, in 2005, increased the budget problems, plus it became politically difficult to eliminate estate taxes on the wealthy when the common folk were suffering. The full-repeal movement finally ran out of steam early in 2006. In its place came big talk of a 15 percent top tax rate (equal to the capital gains rate) and exemptions as high as $10 million. Unfortunately, just as the full-repeal advocates hung on too long, the low-rate/high-exemption folks refused to compromise in time for the Congressional sausage-making process to finish. They couldn’t get enough votes and then time ran out thanks to this fall’s change in control of both houses.

Some believe that the incoming Democrats seriously intend to act with their newfound bipartisan form of glasnost. They expect the new Democratic leadership to quickly pursue common ground with the Republicans to pass legislation, thereby demonstrating their virility. Increasing the minimum wage apparently is one such arena, although the details (e.g., the actual amount and possible relief for small businesses) may prove tough. Could estate-tax reform be a common ground? It certainly seems possible given how close we were to some law change just a few short months ago. But I’m not terribly optimistic.

Since 1991, I have predicted that, when Congress finally acts, the top rate would be fixed at around 40 percent and the exemption would be a few million dollars. I stick by that prediction. I hope I’m wrong and that the relief is more substantive, but I have been around for a long while and I’ve seen sausage being made in Washington.

Estate-planning professionals would love to see certainty in the law. The estate tax’s 2010 death and subsequent resurrection make their and their clients’ lives very complicated. Unfortunately, we may be entering a brave new world of ongoing temporary fixes. Congress might act in the next couple of years to defer the 2010 repeal for a few years. When the full repeal date again approaches, new legislation will be needed to defer it again for another few years. The ongoing political problem will be the need to avoid reversion to the high rate/low exemption (e.g., in 2011), coupled with the revenue-and social-driven motivations to avoid full repeal. At the same time, the revenue cost of permanently enacting low rates and high exemptions may force only modest relief during the temporary-fix period.

The income tax world has been living with this problem for a long time now. In that world, credits (for example, for research and development) are enacted, but with a sunset of a couple of years. Then, Congress must act again to extend them, sometimes retroactively after they have ostensibly expired.

And I continue to worry that during the smoke-filled, backroom sessions, there could be compromises that restrict important planning opportunities, such as grantor-retained annuity trusts, or create taxpayer-detrimental fantasies such as artificial rules to ignore valuation discounts for closely held entities.

So there you have my thoughts. But what does a guy in Houston know about Washington politics anyway? You should keep in touch with your elected representatives and let them know what’s important to the people who elect them. My suggestion is that you encourage them to be realistic this time and to seek permanent relief at realistic rate and exemption levels. And, above all, don’t worry, be happy! Too much stress could cause your estate to “mature” before this mess gets straightened out. Happy New Year!

Ross Nager is Senior Managing
Director of Sentinel Trust Company of
Houston, Texas

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